Download Price Discrimination Law and Economic Efficiency

University of Michigan Law School
University of Michigan Law School Scholarship Repository
Articles
Faculty Scholarship
1982
Price Discrimination Law and Economic Efficiency
Edward H. Cooper
University of Michigan Law School, [email protected]
Follow this and additional works at: http://repository.law.umich.edu/articles
Part of the Antitrust and Trade Regulation Commons, and the Consumer Protection Law
Commons
Recommended Citation
Cooper, Edward H. "Price Discrimination Law and Economic Efficiency." Mich. L. Rev. 75 (1977): 962-82.
This Article is brought to you for free and open access by the Faculty Scholarship at University of Michigan Law School Scholarship Repository. It has
been accepted for inclusion in Articles by an authorized administrator of University of Michigan Law School Scholarship Repository. For more
information, please contact [email protected].
PRICE DISCRIMINATION LAW AND
ECONOMIC EFFICIENCY
Edward H. Cooper*
The Clayton Act, as amended by the Robinson-Patman Act (15
U.S.C. § 13), undertakes to outlaw price "discrimination" upon
proof of threatened injury to competition, and subject to specified
defenses. Lawyers often bewail the fact that administration of this
statute frequently fails to conform to an economist's notion of discrimination. For the most part, the complaints are addressed to the
clear fact that, as drafted and interpreted, the statute wreaks unnecessary damage. In the name of protecting competition, competition
and economic efficiency are often curtailed.
To some uncertain extent, the economic losses encountered in
the administration of a price discrimination law may be accepted in
the pursuit of social or political goals. In the perennial ebb and
flow of proposals to abolish or to amend the statute, however, arguments are continually made that it serves economic goals as well.
Such arguments commonly fail to recognize the enormous difficulties that confront any statutory attempt to improve the pursuit of economic efficiency by regulating price discrimination. These difficulties are so great that a price discrimination statute is apt to serve
economic efficiency only incidentally and accidentally, if at all. These
difficulties do not arise from any supposed fact that price differences
in real transactions must always rest upon foundations of economic
efficiency. Often they do not. Instead, the difficulties arise from
two quite different limitations on economic theory and our ability
to apply economic theory in practice.
The first limitation arises from the fact that price discrimination
is not a single phenomenon, but a wide variety of often complex
phenomena, some of which may prove more desirable than nondiscriminatory pricing. Unambiguous demonstration that a given set of
pricing transactions involves price discrimination does not by itself
answer the question whether it is desirable discrimination. The first
* Professor of Law, The University of Michigan. A.B. 1961, Dartmouth College; LL.B. 1964, Harvard University.-Ed.
The author wishes to express deep appreciation to his colleagues, Professors Peter
0. Steiner and Thomas E. Kauper, who reviewed a draft of this essay and made
several helpful suggestions.
HeinOnline -- 75 Mich. L. Rev. 962 1976-1977
April-May 19771
Price Discrimination
963
part of this essay is a brief and almost allusive reminder of the difficulties that must be encountered in attempting to determine
whether a particular instance of price discrimination is intrinsically
desirable.
The second limitation arises from the difficulties of determining
whether a particular set of pricing transactions in fact involves price
discrimination. These difficulties arise primarily from the complex
variety of considerations that must be taken into account, and the
inadequacy of available measuring devices to account for them. In
some part, these difficulties also reflect unresolved problems in
achieving a suitable abstract definition of price discrimination. In
combination, these sources of difficulty pose great problems for the
administration of any statute that might be drafted in an attempt to
minimize interference with desirable competition and economic efficiency, whether the ultimate purpose is to improve economic performance or to pursue noneconomic goals. The second part of this
essay is an exploration of these problems, illustrated in large part
by familiar issues that have emerged in administering the present
statute. There will be enough shift in perspective, however, to warrant omission of the obvious citations in order to present an abstract
statement of the general problem.
Any reevaluation of present price discrimination law must account for these limitations of discrimination doctrine, both in
theory and in practical application. The conclusion offered here is
that, even with substantial changes in present law, economic efficiency is more apt to be restrained than furthered by any effort at
legal control. If discrimination is to be outlawed, justification must
be found in the pursuit of social and political goals, or in the belief
that long-run economic values may be purchased only at some sacrifice of short-run efficiency.
I.
THE DESIRABILITY OF PRICE DISCRIMINATION
In economic theory, price discrimination means only that the
same product is sold to different customers at prices that are not related to differences in the costs of dealing with them. The clearest
illustration of such discrimination is the charging by a seller of different prices even though all costs are equal. Despite the tendency
of a modern ear to hear overtones of unjustifiable differentiation in
the very term "price discrimination," economists do not mean to imply that all discrimination is undesirable. Matters are much more
complex than that. There are many phenomena of price discrimi-
HeinOnline -- 75 Mich. L. Rev. 963 1976-1977
Michigan Law Review
[Vol. 75:962
nation, some of which are often desirable. A blanket prohibition
of price discrimination, accordingly, would often produce undesirable results. The complexity of these phenomena is sketched in this
section, on the assumption that price discrimination is clearly involved. A discussion of the difficulty of identifying price discrimination is deferred to section II.
A. Monopoly PriceDiscrimination
A comparison of the results of uniform pricing by a "monopolist"
with the results of price discrimination by a monopolist provides the
simplest example of the complex results of discrimination. Assuming that the cost of serving all customers is equal, a competitive
market would ensure equal prices to all customers. Different prices
could be charged different customers only by a firm that has market
power coupled with the ability to prevent low-price customers from
reselling to high-price customers. The gains to such a seller from
charging different prices to different customers result from variations
in the intensity of their demand. Suppose, for example, that it costs
$49 to produce and deliver one fergustrol to any customer, and that
there is one customer who would pay $100 for a fergustrol, four who
would pay $90 for one each, and three more who would pay $50
for one each. If the seller were to price individually, it would sell
eight fergustrols for $610, incur costs of $392 (assuming there were
no costs in identifying the different purchasers' distinctive demands
and preventing arbitrage among them) and realize a pure profit of
$218. If the seller were forced to charge a profit-maximizing single
price, it would charge $90, sell five fergustrols for $450, and realize
a pure profit of $205. At a uniform price of $100, it would make
one sale and realize total revenues of $100 and a profit of only $51,
and at a uniform price of $50, it would make eight sales, and realize
total revenues of $400 and a profit of only $8.
The seller may not be the only one to benefit from the practice
of substituting price discrimination for a profit-maximizing single
price. In the example just given, the profit-maximizing single price
would reduce output from eight units-the level that would be
reached by competitive sellers-to five. In the real world as well,
price discrimination can bring the allocation of productive resources
and output closer to that which would occur in a competitive market,
and it can make the product available to customers who otherwise
would not enjoy it. The major obstacle to achieving this result lies
in the difficulty and the cost of obtaining sufficient information about
HeinOnline -- 75 Mich. L. Rev. 964 1976-1977
April-May 1977]
Price Discrimination
the demand intensities of different customers. Ordinarily, customers are apt to be lumped into groups for purposes of discriminatory
pricing. The result is likely to be reduced output as to the higherpriced groups of customers, and increased output as to the lowerpriced groups. It may be that generally circumstances are such that
on balance output will be increased as compared to that produced
at the profit-maximizing single price. Even if it is not, however, the
product will be made available to some customers who would not
have enjoyed it at the profit-maximizing single price. In more extreme circumstances, it is possible to show that with plausible assumptions about declining costs, price discrimination can result in
lower prices to all purchasers, or even in the production of a product
that could not be produced at all if sales were required to be made
at a single price.
The fact that price discrimination by a firm with market power
may bring the allocation of resources closer to that which would be
achieved in a competitive market does not lead to an easy conclusion
that the law should allow such discrimination. Initially, it must be
recognized that it may often be very difficult to determine the actual
impact of discrimination on resource use. In addition, an expansion
of output in one imperfect market may have been purchased only
at the cost of attracting resources away from another imperfect
market in which they were better employed. Finally, even if price
discrimination brings the allocation of productive resources closer to
the allocation that would result from competition, it is attended by income effects quite different from those that would be achieved by
competition.
The income transfers that attend price discrimination are easily
illustrated. Using the figures employed above, the discriminating
seller who charges $100 to the fergustrol customer with the most intense demand has extracted the $51 "surplus" that the customer
would have enjoyed at the competitive price of $49. Despite
a possible intuitive reaction that it would be better to allow customers to retain and enjoy the surplus generated by the intensity
of their own desires, the income transfer itself may be desirable.
One common example is the small-town doctor, whose income
from discriminating against high-income patients results in locating an office where no doctor would serve if fees were forced
down to a single level that could be paid by all patients. The highincome patients benefit by enjoying a service that would not otherwise be made available. Even if medical services would otherwise be provided, it may be reasonable to assume that many doctors
HeinOnline -- 75 Mich. L. Rev. 965 1976-1977
Michigan Law Review
[Vol. 75:962
seek to attain a satisfactory income rather than a maximum income,
and that the higher charges to rich patients "support" lower charges
to poorer patients. The resulting transfer from the rich to the poor
might well be approved. On a more general level, however, it may
be difficult to establish useful criteria for appraising the desirability
of enabling some customers to enjoy discriminatory prices below a
profit-maximizing single price at the expense of income transfers
from higher-price customers to the supplier.
Price discrimination, in short, is possible only because of market
power. If competition were possible, it might generally be preferred. But once the requisite market power is present, whatever its
sources, price discrimination may have either desirable or undesirable effects on resource allocation and income distribution, and it
may be astonishingly difficult to identify and appraise such effects
in individual cases.
B. Discriminationand Price Competition
Oligopoly markets present some of the most complex phenomena
of price discrimination. Systematized price discrimination may provide a helpful or even essential means of stifling the temptation of
individual firms to engage in price competition that proves costly for
all. Sporadic price discrimination, on the other hand, may serve initially as the only source of price competition in a market in which
none dare to cut prices across the board. Over time, it may proliferate into generalized competitive pricing, or at least lead the way
to oligopoly stability at a lower price level. Prohibition of systematized price discrimination in such a setting could easily have desirable results, but prohibition of all price discrimination could prove
very costly.
The multiple basing-point pricing system once practiced by
cement producers may serve to illustrate the potentiality for adverse
effects from price discrimination in an oligopoly setting. Under the
system, many producing points became "basing points," while some
were not. Prices to all customers were determined by calculating
the cheapest total of a basing-point price plus rail-freight charges
from the basing point. The irrationality of the system is most dramatically shown by considering the pricing practices of a nonbasingpoint seller. Suppose that the price at the nearest basing point was
$1.45 a barrel, and that rail freight to the seller's location was
twenty-five cents. The nonbasing-point seller would charge $1.70
to a next-door customer who took delivery at the seller's own loading
HeinOnline -- 75 Mich. L. Rev. 966 1976-1977
April-May 1977]
Price Discrimination
dock, $1.45 to a customer at the basing point despite freight costs
of twenty-five cents, and $1.70 to a customer who was located at
a twenty-five cent rail-freight cost in the opposite direction from the
basing point. Net receipts on the respective sales would be $1.70,
$1.20, and $1.20.
The aggregate cost to the cement industry of maintaining the
basing-point system must have been staggering in terms of crosshauling and increased selling costs. Yet the cement producers bore
these costs; indeed, there was overwhelming evidence that the system originated in overt collusion and was maintained by overtly collusive behavior. The reasons for colluding to maintain such a costly
system lie in its contribution to oligopoly price calculation. These reasons make it clear that the system was properly held unlawful even
apart from the collusion. Cement is a homogeneous product, and small
price differences can easily shift customers from one supplier to another. The demand of end-users is highly price-inelastic, however,
so that even substantial price reductions would not substantially increase total use. During periods of vast excess producing capacity
and high fixed costs, the pressure on cement producers to seek additional business by shading prices closer to marginal costs was very
strong. Each producer, absent the basing-point system, would have
been left virtually helpless to avoid price competition, even if every
producer had adopted a well-publicized f.o.b. price. Individual customers could have claimed unverifiable advantages in arranging
f.o.b. delivery from different suppliers, or in arranging nonrail transportation. A supplier would have been left uncertain as to the price
that would exactly match those of its rivals. Each supplier, moreover, would be aware that his competitors faced the same pricing
uncertainty and the same temptation to shade prices to win increased
business. The pressure to anticipate price competition from others
-whether deliberate or inadvertent-by a bit of preventive price
competition would have been very strong. Added to these pressures would be the pressure resulting from the fact that over time
demand would be apt to fluctuate much more in the territories of
natural freight advantage peculiar to each supplier than over areas
that embrace many suppliers. Given the will to avoid price competition, the basing-point system made it possible to avoid all of these
dangers. With such a system, each firm knew exactly what price
would be charged by its competitors and that differences in delivery
arrangements would not have significant price effects. Thus, price
competition was successfully avoided, even during the Great De-
HeinOnline -- 75 Mich. L. Rev. 967 1976-1977
Michigan Law Review
[Vol. 75:962
pression. It is almost incredible to suppose that this result could
have been achieved without the basing-point system.
Other pricing systems as well may facilitate oligopoly price calculation and the avoidance of price competition. The basing-point
system, however, suffers peculiar additional disadvantages. To the
extent that it is successful, it may interfere with long-range adjustments in productive capacity, and in times of declining demand it
may facilitate survival of the financially strong rather than the efficient. Customers who purchase products sold on a basing-point
system may tend to locate near basing points rather than nonbasing
point producers, although in the cement industry it seems very
unlikely that many cement users would base their own locational decisions on basing-point locations. If the system is maintained long
enough, it is possible that new production capacity may locate near
the basing points by the self-reinforcing attraction of customers' locational decisions.
In contrast to the impact of systematized price discrimination, sporadic price discrimination may have highly beneficial effects in upsetting oligopoly price calculation. The other side of the picture just
painted for the effects of the basing-point system is that individual
sellers, faced with excess capacity, may often believe that it is worthwhile to engage in hidden price competition. Discriminatorily favorable prices to particularly desirable or fickle customers may be the
most likely form of such competition, in the hope that they may pass
completely undetected, or that if detected they may be ignored or
met with comparably limited competition, or that if detected and met
with generalized price competition the delay in detection will yield
sufficient profit to repay the gamble. Alternatively some firms may
feel compelled to initiate such discrimination and competition by the
fear that others have started already, or may soon start.
These contrasting aspects of price discrimination in an oligopoly setting suggest that it would be more useful to focus directly
on the problems of oligopoly pricing systems than on the fact that
one or more individual sellers are engaging in discrimination. It is
possible to urge that the effect of reducing price competition is a
desirable means of avoiding excessive rivalry that could lead to
wasteful fluctuations in capacity over the general economic cycle.
This argument has not been accepted with respect to explicit pricefixing, and it probably should not be accepted with respect to a systematized method of price computation adhered to by individual oligopolists without explicit collusion. Present conspiracy doctrine
could easily be expanded to prohibit undesirable oligopoly pricing
HeinOnline -- 75 Mich. L. Rev. 968 1976-1977
April-May 19771
Price Discrimination
systems without requiring proof of some traditional form of "agreement." If such an approach proves inadequate, however, it would
be better to seek a remedy in new legislation addressed to the problem of oligopoly behavior rather than to rely on concepts of price
discrimination as such.
C. Statutory Concerns
Present price discrimination law focuses largely on two forms of
injury. One is the injury that results from predatory or disciplinary
pricing designed to destroy rivals of the seller or to deter them from
competing. The other is the injury to competition that exists between firms that purchase from the same seller through low-priced
and high-priced channels of distribution. These two forms of injury
pose quite different challenges to price discrimination law.
Discrimination is a curious companion of predatory or disciplinary
pricing. It is clear that the immediate source of concern is that low
prices may be used for bad purposes; the immediate cause of injury
is the low price, not the discrimination. There is ample cause to
believe that predatory pricing is very rare and to wonder whether
disciplinary pricing is much more frequent. In any event, discrimination contributes to the process only if it somehow supports the
lower prices. The only argument in favor of such support is that
firms are more likely to engage in undesirable low pricing if it can
be supported out of profits realized from other sales of the same
product than if it must be supported out of an equal amount of other
funds. The business psychology assumed by this argument is not
entirely fanciful. In addition, it is possible to make the prophylactic
argument that a statutory policy of single pricing would discourage
predatory and disciplinary pricing by increasing the cost. Finally,
the very fact of discrimination may be of some slight value in
measuring the desirability of the low price. These concerns cannot
be rejected out of hand. Nonetheless, they must confront both the
danger that what appears to be disciplinary pricing may reflect desirable competition and the difficulty of measuring accurately the existence of price discrimination.
Injury to competition between customers of the discriminating
seller is easily understood. Customers who pay higher prices than
their competitors pay are hampered in their competitive efforts. The
major difficulty with building price discrimination law around this
concern lies in the difficulty of determining whether price differences involve discrimination or a desirable response to competition
and considerations of efficiency.
HeinOnline -- 75 Mich. L. Rev. 969 1976-1977
Michigan Law Review
[Vol. 75:962
In summary, then, conduct that clearly involves price discrimination may have desirable or undesirable consequences. The nature
of the questions that must be resolved in evaluating the consequences is such that evaluation is often very difficult. No one has
yet suggested how to define understandable statutory categories of
desirable and undesirable discrimination, or how to administer a
statute that would simply prohibit undesirable discrimination.
These problems are encountered even on the assumption that
price discrimination has been clearly shown. As is demonstrated in
the next section, however, enormous difficulties are also encountered
in any attempt to determine whether a given set of pricing transactions in fact involves discrimination.
II.
IDENTIFYING PRICE DISCRIMINATION
The difficulties of identifying price discrimination in actual transactions present challenges to statutory regulation quite distinct from
the difficulties of distinguishing between desirable and undesirable
discrimination. The difficulties begin with the problems of identifying and adjusting for differences in measurable costs, and are exacerbated by differences in the time periods of various transactions,
the full range of appropriate responses to competitive pressures, arrangements that reduce uncertainty, and compensation for services
performed by buyers. These difficulties are explored below. Separately or together, they often raise high barriers to the task of administering a rule against discrimination without interfering with economic efficiency and competition.
A. Cost Variations
As soon as different costs are incurred in providing substantially
the same product to different customers, difficulties emerge in
measuring and adjusting to the differences, even with respect to the
tangible "hard" costs of production and distribution.
An initial difficulty of measurement arises from the nature of cost
accounting. In many circumstances, it is simply not possible either
to create an abstract model or to generate the data needed to establish an absolute cost figure. The most that can be done is to adopt
a reasonably plausible system that will provide consistent figures over
time that are useful for some internal management purposes. Because of these difficulties, it would be foolhardy to legislate a requirement that all prices be varied to maintain a uniform relation
to the costs of each transaction, and fortunately no such requirement has ever been attempted. Single pricing is accepted without
regard to possible cost differences.
HeinOnline -- 75 Mich. L. Rev. 970 1976-1977
April-May 1977]
Price Discrimination
A closely related difficulty shows the need to confine even a theoretical model of price discrimination. It may often be so expensive
to determine the costs of different transactions, and to adjust prices
accordingly, that the cost and price of the lowest-cost transactions
would be increased above the single price that would prevail in the
absence of such an adjustment. In such circumstances there is no
sensible economic model that would suggest that sellers should
undertake the burden of adjusting all prices to relative costs. Alternatively, a seller may be able to group customers according to a
readily identifiable characteristic or group of characteristics roughly
corresponding to the different costs incurred in dealing with them.
The result may be a more rational relationship of prices to costs than
would result from single pricing, and it may not be feasible to
achieve more refined differentiations. Here too, there is no sensible model of economic efficiency that would suggest that such
grouping should be prohibited in favor of single pricing.
Even if all costs could be determined accurately and at negligible
cost, there is substantial difficulty in creating a model to define the
appropriate method of relating prices to cost differences. Again,
using simple figures, suppose it was determined that all of the directly measurable costs of dealing with one customer total $60,
and that all of the directly measurable costs of dealing with another
customer total $80. If the price to the high-cost customer is
$100, what price is appropriate for the low-cost customer? Is
it $80, reflecting only the absolute amount of cost savings? Or
is it $75, reflecting the same proportion between price and measurable costs as the price charged the high-cost customer? Distressing
as it may seem, either answer may be clearly right in some circumstances, and each may be highly questionable in most circumstances.
Absolute cost differences are probably the appropriate measure
of price differences if they rest on payments that are entirely external
to the firm and that do not reflect any of the myriad economic functions undertaken by it. If, for instance, the seller incurred common
carrier charges of $5 in delivering to one customer, and $25 in delivering to the other, there is a strong argument that cost justification
appears only to the extent of the $20 difference.
Final prices should probably be proportional to measurable costs
in situations in which all measurable cost differences reflect costs that
are internal to the firm. The clearest situation is presented by a
firm that can measure and allocate some, but not all, of its internal
costs. If it can measure costs of $60 in dealing with one customer
and costs of $80 in dealing with another, it seems appropriate to allo-
HeinOnline -- 75 Mich. L. Rev. 971 1976-1977
Michigan Law Review
[Vol. 75:962
cate the unmeasurable costs in the same proportion as the measurable costs. The unmeasurable costs are internal to the firm, and reflect risks undertaken by it that deserve to be compensated. The
same conclusion seems justified if the firm can superficially allocate
"all" of its historic internal costs. If it can secure a price of $80 in
selling to a $60 cost customer, the opportunity costs, rents, returns
to risk, or pure profit that it is earning should be charged in the same
proportion to higher-cost customers.
Unfortunately, these conclusions seem weaker with obvious variations of the underlying assumptions. Suppose, for instance, the firm
maintains its own fleet of delivery trucks and can demonstrate a
highly rational $20 savings in the cost of delivery, including a reasonable return to the investment and risk incurred in the delivery
system. Should the $20 cost difference "justify" a $25 price difference on the ground that the high delivery-cost consumer should bear
a greater share of the president's salary and the investment and risk
in machine tools? It is difficult to find any clear answer.
The assumption of constant costs in dealing with all customers,
in short, makes it relatively easy to define and identify noncost
pricing. Once the assumption is discarded, however, it becomes
more difficult to identify or define noncost pricing, even if attention
is directed only to the obvious "out-of-pocket" costs of production
and distribution. If there were no other reason to question the assertion that every customer should bear an appropriate share of
nonallocable "overhead" costs, differences in measurable hard costs
make it difficult to define the appropriate share. These problems
pale to near insignificance, however, when they are compared to the
allocation problems that arise from the more intangible costs of risk,
uncertainty, and services incurred or avoided by the buyer.
B. Time Variables
Two different perspectives suggest the major ways in which differences in time complicate the relationships between prices and
costs. First, cyclical fluctuations in demand must be taken into account. Second, transactions concluded at the same moment may involve different future time periods. Each of these perspectives introduces elements that cannot be neatly captured and translated into
appropriate variations in the price-cost relationship.
Cyclical fluctuations in demand that affect all sellers of the same
basic product have an obvious impact on prices. Such fluctuations
may occur irregularly as a result of the overall health of the eco-
HeinOnline -- 75 Mich. L. Rev. 972 1976-1977
April-May 1977]
Price Discrimination
nomy. They may also occur predictably, following regular patterns
peculiar to a specific industry. It is clear that transactions undertaken at different stages of such cycles cannot be compared. Customers who purchase in seasonal slack periods and incur storage
costs, for instance, obviously should not be required to pay the same
price as customers who defer purchases until the hectic peak period.
Even customers who purchase for immediate use in the slack period
may rightly assert that they should not be required to share the cost
of facilities maintained solely to satisfy peak demand. More generally, it is accepted that in periods of general excess capacity in an
industry prices should tend toward the short-term variable costs of
production, while in periods of inadequate capacity prices should exceed the full costs of production.
General industry cycles do not afford any basis for measuring and
assessing an appropriate degree of change in cost-price relationships.
They do provide, however, a useful basis for determining that transactions undertaken in one phase of a general cycle cannot be compared to transactions in another phase. In addition, they provide
a provocative analogy by which to frame the question whether
periodic changes in the demand perceived by a single firm warrant
similar price changes in the absence of any change in overall market
conditions. It is plausible to argue that whenever a firm believes
that it will not be able to operate at full capacity at the price of its
most recent transactions, it should be able to lower the price to all
customers until it believes that capacity operations are ensured. The
difficulty with this argument is that it suggests that a seller should
be able to charge whatever price it thinks it can obtain from each
of its customers in order to remain as close to continual full capacity
operation as possible. Prices would respond to the bargaining power
and ability of sellers and buyers. Although there is no self-evident
reason why bargain-determined prices are less efficient than those
determined by more impersonal market forces, there is no need to
reach a firm conclusion on this point. It is sufficient to note that
there is an unresolved difficulty.
Transactions covering different time periods provide easier tests.
Whenever the buyer or seller undertakes a legally binding commitment for the future, the transaction ceases to be comparable to spotmarket transactions or transactions covering commitments for different periods in the future. Risks are assumed that demand compensation. There is no reason, for example, why the price for
a carload of potatoes delivered three months from today should be
the same as the price for present delivery plus the cost of storage,
HeinOnline -- 75 Mich. L. Rev. 973 1976-1977
Michigan Law Review
[Vol. 75:962
even if both carloads have already been harvested and put in storage.
Nor is there any means of measuring a "reasonable" risk factor to
adjust the relationship between price and the physical costs of production. Even in organized futures markets, the relationship between prices is based on the conflicting judgments of many traders,
drawing from predictions of both demand and cost. Potatoes to be
delivered in three months, in short, are not the same product as
potatoes delivered on the spot.
Apart from the risk and product-definition factors, it is reasonable
to argue that prices in different time periods should not be compared
whenever time differences permit different degrees of variation in
tangible costs. The longer the time period the greater the number
of cost elements that can be varied. There is no apparent reason
to demand an identical relationship between prices and costs that include different variable and fixed components. Suppose two separate contracts were made on January 1, 1975, and January 1, 1976,
each calling for the delivery of an identical quantity of the same
product on January 1, 1977. If more inputs could be varied over the
two-year period than over the one-year period, there is no reason
to insist on a uniform price even though all output might be produced in December 1976, at an apparently uniform cost.
The time dimension, in short, means that a comparison of costprice relationships is clearly justified only as to transactions that are
undertaken at substantially the same time and involve performances
over substantially the same period. It may be possible to draw upon
recognized patterns of commercial significance to expand the comparable periods to some extent, particularly if there are well-established market periods and the selling firm operates at a constant
relation to capacity and cannot show any reason to expect a change.
At a very early point, however, it will become impossible to assume
comparability. Appropriate adjustments for incomparability would
be hazardous, and often capricious. It might be possible to respond
to this difficulty by asserting that sellers are free to set different
prices for different future periods, but that they must allow free access
by all customers to purchases on the same terms for any future period.
This response will not do, for future commitments by the seller, in
reliance on the commitment of the customer, are a form of credit that
should not be subject to legal tests of discrimination.
C.
Meeting Competition
As a practical matter, the most formidable obstacle to legal regulation of cost-price relationships arises from the fact that many sales
HeinOnline -- 75 Mich. L. Rev. 974 1976-1977
April-May 19771
Price Discrimination
are made with little or no regard to cost. Market constraints limit
the seller's freedom, even if they do not determine a unique single
price. Any sale that covers variable costs and represents the most
favorable opportunity available to the seller is good business. The
available opportunities are in turn shaped by competition, both from
close substitute products and from quite different customer expenditures or investments. The need to meet competition means that
sellers often cannot consider the full long-range costs of each sale.
More importantly, it means that sellers are apt to adjust prices according to estimates of the opportunities left open by competition:
better prices are likely to be available to marginal customers simply
because of the danger that they will go elsewhere. The pressure
to adjust prices to meet alternative competitive opportunities open
to buyers is so strong that attempts at regulation face immense practical obstacles. The Robinson-Patman Act is violated almost as often
as highway speed laws. Despite the practical problems of enforcement, speed laws make sense both because they have a very pervasive practical impact and because there are sound reasons for controlling automobile speed. The practical problems of enforcing price
discrimination laws, on the other hand, reflect deeper theoretical
problems. For a host of reasons, business firms should indeed be
left free to respond to many of the pressures that force them to compete in the short run.
One of the most commonly stated theoretical reasons for favoring
competitive variations in price-cost relationships arises from the
nature of oligopoly pricing. At a minimum, a firm with substantial
pricing freedom often lacks clear market information on the most
appropriate price. Selected price variations may provide the most
efficient method of gathering information about demand and thereby
improve the opportunities for price competition. Beyond the information function, firms in an oligopoly market may employ selective
price cuts, often secretly, in an attempt to secure sales that might
otherwise be made elsewhere, as was described in section I. Enforced price uniformity might well remove the most probable opportunity for price competition in important oligopoly markets.
Price discrimination may also be adopted as one of the most efficient means of competitive promotion. Price reductions may be
offered in selected markets or to selected customers for the purpose
of inducing experimentation and future sales at nondiscriminatory
prices. The result may better enhance competition and better serve
customers than would alternative forms of advertising and promotion.
HeinOnline -- 75 Mich. L. Rev. 975 1976-1977
Michigan Law Review
[Vol. 75:962
Variations in cost between different firms provide quite different
reasons for favoring prices that respond to competitive opportunities
rather than to individual firm costs. Even single-product firms that
employ the same technology and the same tangible inputs may experience differences in the total costs of serving different customers.
There is every reason to allow each customer to enjoy a price that
corresponds to the costs of the firm that can serve it most efficiently,
and to subject that firm to competitive pressure from other firms.
And there is no reason to deny any rival supplier the right to meet
the efficient firm's price if the sale would be the rival's best opportunity.
The same point holds true, in much more complex fashion, in situations in which different firms produce differentiated products, in
different overall product mixes, employing different technologies.
Initially, it is clear that there is no reason why any firm should be
compelled to maintain a constant relationship between the prices and
costs of its different products. Each product is sold in a different
market, facing different supply and demand conditions (often at different points in individual market cycles), and must be treated as
a distinctive pricing problem. Even with respect to a single product,
all customers may benefit from a flexible response to differences in
demand that result from variations in the attractiveness of substitute
products to different users. Increased output of one product in the
firm's product mix may provide the benefits of noncost pricing not
only to other customers for the same product, but also to customers
who purchase different products from the same firm. It is, moreover, possible that response to market opportunities may provide a
more rational range of relationships between prices and costs than
would emerge from self-conscious attempts at regulation, given the
fact that none of the firms is apt to have any clear picture of the
allocation of its own costs among its different products, nor any
means or sound business reason for developing a clear picture.
The meeting competition arguments also provide a new perspective on the capacity utilization concerns explored earlier. Meeting
competition arguments suggest that a firm with excess capacity
should be able to utilize its capacity by pricing down to the most
favorable opportunity it can seize. Allowing such behavior, without
requiring reduction of prices for all transactions, may achieve the
best utilization of total industry capacity and provide individual customers with the most favorable combination of price and product variety. The assumption that each customer should bear the same aliquot share of fixed costs, built into present price discrimination laws,
HeinOnline -- 75 Mich. L. Rev. 976 1976-1977
April-May 19771
Price Discrimination
may injure both sellers and buyers. If all prices must be reduced
to capture the marginal buyer, the seller may find it better to forgo
the marginal sale, thereby passing up its contribution toward overhead. Over time, this pattern could result in less efficient investment in plant, technology, and product mix to the harm of all concerned.
The argument based on capacity utilization can be illustrated with
figures drawn from a closely related argument based on the advantages of capacity expansion. This argument also shows that the competition to be met includes the competition from potential entry, including potential vertical integration by present customers into the
seller's market. Suppose that the largest current plant for producing
thingbobs has an annual capacity of 10,000 units, at a full cost of
$1 each. Developments in technology have made it possible to
produce at a cost of $1 in plants having an annual capacity of 2,000
units, and to produce at a cost of 85¢ in plants having an annual
capacity of 20,000 units. Recapture of an investment in plant
expansion is doubtful, however, since there is already some excess
capacity, and it seems probable that, given competitive response and
the relative inelasticity of demand, the largest firm could not sell
more than 14,000 units at a price of 850. At the same time, several
large customers have been exploring the possibility of building
2,000-unit plants in order to avoid reliance on the market. Discussions with some of them have shown that the advantages of internal
production, even at a unit cost of $1, are great enough to justify internal expansion unless a market price of 80¢ is available. The large
firm has concluded that if it expanded to a 20,000-unit capacity, it
should be able to sell 12,000 units at a price of 95$ and 8,000 additional units at a price of 80¢ to four large customers. All customers
would then be better off. Although competitive relationships between the small and large customers would be altered, internal
production by the large customers would alter the relationship as
well, giving the large customers advantages they value highly. The
supplier should be allowed to adopt its proposed program.
The risk reduction perspective provides another useful view of the
meeting competition concern. An individual seller can never know
the highest price that will secure a marginal sale, thereby "meeting"
competition. This difficulty is particularly acute when product differentiation requires calculation of appropriate price differences, and
when there is room to calculate the value to the customer of the advantages of continuing an established relationship or the disadvantages
of establishing a new relationship. The only rational behavior is to
HeinOnline -- 75 Mich. L. Rev. 977 1976-1977
Michigan Law Review
[Vol. 75:962
offer the price that best balances added revenue against the risk of
losing the sale. Any attempt to measure the appropiateness of this
price as simply meeting rather than "beating" competition is doomed
to failure.
So long as price competition is thought desirable, in short, it must
be a short-run phenomenon that forces disparities in the relations between costs and prices. Only a thorough substitution of regulation
for market transactions could alter the results.
D. Reduction of Uncertainty
The most complex arguments confounding the relationship between prices and costs arise from the intangible and unmeasurable
costs imposed by uncertainty. Two illustrations will be provided to
demonstrate that at times considerations of uncertainty may justify
different prices despite identity in all of the measurable costs of production and distribution. A third illustration will be used to show
that at other times considerations of uncertainty may not justify different prices. The conclusion to be drawn from these illustrations
should become apparent: since there often is no practicable way of
measuring the appropriate price adjustment to compensate for reductions of uncertainty, no regulation of pricing could avoid prohibiting highly desirable behavior.
The first illustration parallels an example already used in a different context. Shortly before the start of a year, one customer enters into a binding contract to take delivery of 10,000 units at the
first of each month in the following year at the seller's prevailing
price. A second customer, without making any such commitment,
in fact orders 10,000 units for spot delivery on the first of each month
during the same year. Analysis of the provable costs of dealing with
each customer shows that all costs are the same. Nonetheless, there
is no reason to deny the right of the firm-commitment customer to a
price reduction that reflects the commitment assumed in the contract.
Indeed, this commitment may have reduced the seller's uncertainty
as to the probable ranges of output during the year, facilitated the ordering of variable inputs, conduced to improved production flow, and
thereby reduced the costs of dealing with all customers. Apart from
such tangible savings, increased certainty may well permit lower returns to capital. The very same phenomena can occur without a contractual commitment. The seller, for example, could adopt a price
schedule that provides retroactive rebates based upon the cumulative
purchases of each customer during the year. Experience with the
market might enable the seller to judge the effects of the discount
HeinOnline -- 75 Mich. L. Rev. 978 1976-1977
April-May 19771
Price Discrimination
schedule, to reduce uncertainty, and to reduce overall costs of the
operation in ways that cannot be measured or even demonstrated.
Even though all customers purchase in spot delivery transactions and
there is no difference in measurable costs, the regularity induced by
the retroactive rebate may reduce costs in all transactions.
The second illustration is simply a variation on the first. In many
markets there may be some buyers that regularly purchase large
quantities and that customarily prefer to deal with an unchanging
small group of suppliers. Lower prices to these buyers may be justified in part by the meeting competition concerns already explored;
to a large extent, the fact that they enjoy a greater range of competitive alternatives may reflect nothing more than cost savings enjoyed
by one seller or another at various times and in various ways. In
addition to these considerations, however, lower prices may also be
justified on grounds parallel to those identified with the cumulative
volume of purchases discount. The actual experience of the sellers,
both individually and collectively, is that a consistent price advantage
results in markedly steadier purchasing patterns, reducing uncertainty and facilitating planning. Once again, the net result could be
that all buyers benefit.
The third illustration runs counter to the second. Special prices
to large buyers may result from nothing more than the desire of each
firm to reduce the danger that it will lose a particularly attractive
customer. Among sellers collectively, the result may be that, in an
imperfect market, price competition works effectively as to large
buyers, but not as to small buyers. It is even possible that the
profit pressure resulting from competition for large customers enables the oligopolists to maintain higher prices for small transactions
than would result if uniform prices were adopted for all transactions.
Bizarre as it may seem, it is not impossible that lower prices to some
customers could thus "cause?' an increase in other prices. It is very
difficult to find any model of economic efficiency to justify this result, and very easy to fear the impact on competition between large
and small customers that otherwise are equally efficient.
The uncertainty factor thus complicates the price picture still further. It is hard to find a practical measure of the cost savings that
result from reduced uncertainty. It might be tempting to argue that
whatever price has been set must be an accurate reflection of all
the factors of meeting competition and reduced uncertainty, since
the price has been made by a firm that at least is trying to make
the best of its own expert market judgment. Unfortunately, the
market may work more efficiently with respect to some transactions
HeinOnline -- 75 Mich. L. Rev. 979 1976-1977
Michigan Law Review
[Vol. 75:962
than others. But if the market cannot be relied upon to achieve
model-perfect results in all transactions, it may nonetheless work far
better than any nonmarket attempt to sort out and weigh all of the
confused and potentially conflicting elements.
E.
Customer-PerformedServices
Customers engaged in distributing a manufacturer's product may
perform a wide variety of services that benefit both supplier and ultimate buyers. The market in which these intermediate distributors
operate may function so as to reimburse the costs of such services,
but that is not always so. It may often be entirely appropriate to
allow the seller to reduce its prices to support customer services in
reselling the product, even though there is no difference in the costs
of dealing with customers who perform services and those who do
not.
An example of customer-provided services that has become familiar in the context of various vertical restraints is the demonstration
of stereo equipment. Some stereo stores make substantial investments in providing demonstration facilities that enable customers to
compare different equipment, while other stereo stores do not. It
may prove very difficult to prevent buyers from shopping in the
higher-priced demonstrator store and buying at a lower-priced store
that has not incurred the costs of demonstration facilities. One possible way to prevent this may be for the supplier to provide a discount
to stores that meet specified standards of demonstration performance.
The discount enables the stores to provide the demonstration facility,
thereby enhancing the sales of the equipment from all outlets, and
at the same time to remain competitive in price with the other stores.
It may be much more efficient for the manufacturer to purchase this
service by a price discount than to provide the service directly, particularly since most efficient retail distribution may require sale of
many lines of equipment. The price discount, further, may restrict
competition among dealers less than such an alternative means of
protection as an exclusive distributorship.
It is not an answer to say that the manufacturer should allow all
customers access to the form of distribution subsidized by a lower
price. In many market settings, efficient distribution may require
a limit on the number of distributors that provide the service. A
familiar illustration is the "stocking jobber." A manufacturer may
find that sales of its products are greatly enhanced if all end
users have prompt access to replacement parts or additional units out
HeinOnline -- 75 Mich. L. Rev. 980 1976-1977
April-May 19771
Price Discrimination
of a local distributor's inventory. At the same time, most sales may
be made more efficiently by order for delivery direct from the manufacturer to the customer. It may make excellent sense to provide
a price discount to enable a single distributor in each market area
to provide the inventory-stocking service and to limit all other distributors to the function of securing orders for delivery from the manufacturer.
Functional discounts may be justified by the same arguments. Although there may be identical costs in dealing both with wholesalers
who redistribute to small retailers and with large, direct-buying retailers, it may be entirely proper to allow lower prices to the wholesalers.
If there is to be any limit imposed on the price advantages given
to customers on account of distribution services performed by them,
it is plain that it cannot be based on costs incurred by their supplier.
Instead, the limit must be defined with respect to the costs and risks
incurred by the distributors. Even then, the task of regulation seems
almost hopeless. A large and very well-known retailer, for instance,
may incur costs of overall operation that cannot possibly be identified to any single product it carries. By simply carrying a particular
product, such a retailer may provide substantial benefits both to the
manufacturer and to other distributors who carry the same product,
because of the quality and prestige associated with all products handled by that retailer. Any attempt to identify such effects, or to
measure the compensation appropriate for them, would be rash. It
may be that there is no such effect when the nation's largest grocery
chain carries the nation's best-selling brand of corn flakes, but if that
judgment is sound, there are few judgments that could claim even
the same shaky degree of confidence.
III.
SUMMARY
Enough has been said to demonstrate the two basic propositions
urged at the outset. Even when it is clear that price discrimination
has occurred, it remains a complex task to sort through the many
different phenomena of discrimination and to evaluate their desirability. In addition, the appropriate relationship between prices and
costs is extraordinarily complex. Not only is cost accounting imperfect, but prices should and do respond to a great number of factors
that cannot enter into any accounting of investments made or external obligations incurred. In many situations, a firm may not only
increase its own profits but also promote economic efficiency by set-
HeinOnline -- 75 Mich. L. Rev. 981 1976-1977
Michigan Law Review
[Vol. 75:962
ting different prices to respond to differences in the demand for its
product presented by different customers. In light of the inadequacy of the diagnostic tools available to judicial or administrative
tribunals, or to the business firms they might be charged to regulate,
it would be unwise to pursue the task of regulating price discrimination for the purpose of promoting the values of competition and
economic efficiency. If regulation is to be justified for other purposes, it must be justified in terms that acknowledge that it will often
impair economic efficiency.
The most likely goal to be pursued by regulation would be the
protection of small firms. Regulation of price discrimination by their
suppliers will sometimes protect small firms against economically undesirable pricing. More often, it will protect them against destruction by their own economic inefficiency. Immediate social and
political values might nonetheless warrant the effort. If regulation
is to continue, however, substantial changes should be made in present law to raise the threshold of injury, to recognize the full range
of cost-justification complexities, to understand the nature of meeting general market competition, to reflect the importance of reducing risk and uncertainty, and to accommodate the need to recognize customer-performed services. No better judgment seems possible than that a much-improved law would still be widely ignored
and would still lead to condemnation of many price differences that
in fact promote economic efficiency. Only a legislative body can
reach the final judgment whether these losses are justified in the
service of social and political ends that may occasionally, often by
chance, improve economic efficiency as well.
HeinOnline -- 75 Mich. L. Rev. 982 1976-1977